Broad Based BEE

Knickers in a knot

Supposedly “final” codes of good practice on B-B BEE ownership appeared
to recognise black membership of retirement funds for scorecard purposes,
despite protestations to the contrary from the Department of Trade & Industry
(DTI). Many funds can easily meet the defined criteria. But now the DTI wants
submissions on whether, and how, “indirect ownership” should be recognised.

Somebody, somewhere high up in the
Department of Trade & Industry (DTI), is having
a big rethink. What had seemed clear as crystal
from the first phase of the “final” good practice
codes for the broad-based black
economic empowerment (B-B BEE) scorecard,
released last November, turns out to be clear as mud.

Back into the melting pot is whether shares held by black
members of retirement funds – and various other
categories of indirect shareholding, such as private equity
– should be recognised for purposes of the ownership scorecard.
Responsibility for the anomalies must be laid squarely at
the door of DTI for having sidestepped share ownership via
retirement funds. A perfectly legitimate interpretation,
vigorously disputed by the DTI, is that the first phase
implicitly recognises this ownership.

In December, however, the DTI released the second phase,
which deals with a set of different issues such as preferential
procurement, employment equity and skills development.
At the same time, it returned to the first phase by the ministry requesting “public submissions and recommendations
as to appropriate recognition of ownership contributions to
B-B BEE facilitated through indirect ownership”. Because of
urgency, says DTI, the submissions must be made by March.

“From the various public responses received,” the DTI
noted in December, “there are extremely divergent views
among stakeholders . . . as to whether indirect ownership
should be recognised and as to the basis upon which it may be
recognised”. Did higher authorities intervene? “Government,”
says the latest statement, “recognises the important role that
indirect ownership can play in advancing the objectives of
BEE”.

Let’s stop playing with words. Even the term “indirect
ownership” invites ambiguity. The crux of this matter has
to do with beneficial ownership, irrespective of the vehicle,
and not indirect ownership. Shares held by black individuals
through companies such as Safika and Wiphold, for instance,
are no less beneficial and no more indirect than shares held by
retirement funds and collective investment schemes managed
by financial institutions. Or so it should be, unless the codes
are allowed to undermine the principle of shareholder
equality.

The first phase of the codes, issued in November, was
intended for gazetting under the B-B BEE Act. Unlike the
drafts, it omitted any mention of pension or provident funds.
From this absence of exclusion it can be inferred that
retirement funds meeting the codes’ criteria in fact qualify for
inclusion. In other words, the ownership of shares in
companies by black people through retirement funds is
recognised.

FIRST PHASE FINE AS IT STANDS

As such, the first phase is fine as it stands. There is
ostensibly no need for further submissions except as a
ploy for DTI’s nose to be put back in joint.

Taking the codes for what they say, as opposed to what the
drafters might have intended, the consequences are profound.
At one level, it will become easier for companies to reach their
25 percent ownership targets. At another, it can advance the
role of black fund members in B-B BEE transaction
financing rather than cause them sacrifice. At a third, by
bringing black members to the fore, it should stimulate the
shareholder activism that National Treasury wants to
encourage and that the Financial Sector Charter commits
institutions to pursue as the fiduciary managers of retirement
funds (see box).

This is as it must surely be. There are no ownership
vehicles more broadly based than retirement funds. They
house over R1 trillion of assets for almost 10 million
members.

Cosatu, with significant business support, has
vigorously argued that retirement funds frequently represent
the only savings of black workers and often are the sole means
by which masses of people share in companies’ ownership.
Exclusion of long-term black savers would therefore be
illogical. It would also be unfair.

Historically, from introduction of a new labour
dispensation in the 1980s, unions sought to use black
members’ assets for anti-apartheid pressure on corporate
behaviour. Later, under the democratic dispensation, the
intent to empower workers gained momentum with the 1996
Pension Funds Act amendment entitling fund members to 50
percent representation on trustee boards.

THE ONGOING TIDE OF B-B BEE

More than this, the ongoing tide of B-B BEE transactions
requires that somebody pays. Usually, it is existing
shareholders. Especially with public companies listed on
the JSE, by no means are these shareholders exclusively or
even predominantly white. Invariably and substantially, they
include financial institutions on behalf of retirement funds.

So, when new shares are issued by companies to B-B BEE
consortia, the retirement funds’ shareholdings in those
companies are diluted; fund members’ proportion of shareholding
is reduced, which means they will receive a lower
proportion of dividends and hence lower retirement benefits. It also means their share of ownership is reduced, resulting in
them having fewer votes at shareholder meetings.

Particularly when new shares are issued at a discount to
the prevailing market price, broadly based retirement funds
additionally subsidise a transfer of wealth to consortia that are
less broadly based. This is perverse.

Then, when the favoured consortia want to exit from
JSE-listed shares, inevitably the prospective buyers include
retirement funds. So the consortia get in earlier at a special
price and the funds later at a full price, the difference being
the profit to the consortia at the expense of the funds. This is
elitist.

A main argument against inclusion of retirement funds in
the B-B BEE codes is that black members cannot be separately
identified. This is false.

Although funds tend not to profile members on the basis
of colour, they have records enabling them to do so with
similar efficacy to companies filing reports under the
Employment Equity Act. It simply requires effort, for which
the “follow-through” principle in the codes provides. The
principle is used to determine “the entitlement of any
category of black people to participate in an economic interest
or exercisable voting right of a measured enterprise”.

The codes’ definitions clearly embrace retirement funds’
black members, or at least set out criteria that these funds can
meet. For example:

A benefit scheme means “a broad-based ownership
scheme in which more than 50 natural persons are
intended to benefit from an economic interest received by
the scheme or by the fiduciaries of the scheme, and the
economic benefits paid by the economic interest received
is not distributed but rather applied to the scheme’s
deemed participants”;

A broad-based ownership scheme means “a collective
ownership scheme constituted with the view to facilitating
the participation of specified natural persons in the
benefits flowing from the ownership of that scheme or by
its fiduciaries of an equity interest in an enterprise”;

The first step should be for a fund, wanting its black
members recognised for B-B BEE purposes, to identify and
quantify them. It will put them in line for B-B BEE benefits.

Or a company, wanting scorecard credits for black
members of retirement funds holding its shares, can
conduct the exercise. Say Company X is 20 percent owned by
a retirement fund of whose members are 50 percent black.
The scorecard credit for this company would be 10 percent
B-B BEE ownership. The more black members in the more
funds that are beneficial shareholders, irrespective of the
number of institutions that nominally represent them, the
faster the company effectively reaches its 25 percent scorecard
target for black ownership.

There are conditions to be met. Among them:

Only the black members of a fund, not a fund itself, will
qualify as members of a broad-based ownership scheme;

The constitution of the scheme must be structured to
allow the scheme or its fiduciaries no discretion in identifying
deemed participants and the proportions by which each will
share in the economic interest;

All the participants must be entitled to participate in the
appointment of the fiduciaries, at least one of whom must be
an independent person suitably qualified to participate in the
scheme’s financial management;

The scheme’s financial statements must be presented, with
intelligibility, to participants at annual general meetings.

To the extent that funds don’t comply already, they have
the capacity to readily do so. All this seems sufficiently evident,
but it does leave certain questions:

What’s the position of the Public Investment
Corporation (PIC), given that “capital invested by an organ
of state” is excluded? The PIC manages the Government
Employees Pension Fund, by far the largest investor on the
JSE. Arguably, the fund is a separate legal entity whose assets
are owned by its members; while the PIC is owned by the
state, the fund’s assets aren’t.

Will it be possible for companies to increase the shareholdings
of their employees’ retirement funds for maximum
scorecard credit? No. By regulation, a fund may not invest
more than five percent of its assets in the sponsoring
employer. Also, an increase in the fund’s shareholding will
require approval from its employee-elected trustees.

How are multi-managers, who invest large pools of
funds and whose portfolios are fluid, to keep track of
beneficial shareholders? That’s a real problem for multi-managers
to resolve.

On this interpretation of the final codes, the earlier
drafts are eclipsed for equity and excitement.

CONSISTENT GOALS

A reminder of relevant excerpts from the Financial
Sector Charter:

The growth and development of the financial
sector is central to the successful
implementation of BEE and is an overriding
principle and objective of this charter;

Pension-fund trustees, fund managers and
consultants play a critical role in influencing the
flow of funds. Initiatives will therefore be
developed to enhance their understanding of
investments in general and specifically their
participation in targeted investments and BEE
transaction financing and to make a material
contribution to shareholder activism;

Pension-fund trustees are encouraged to play an
increasingly active role in promoting the
objectives of the charter on their respective
boards and in the entities in which they have
taken significant investments.

In similar vein, the National Treasury
discussion document on retirement-fund reform
states: “Shareholder activism by South African
retirement funds is still in its infancy and should be
encouraged.” It cites with approval:

A US Labour Department Interpretative Bulletin
informing fund trustees that they are required to
exercise the votes attaching to shares owned by
their funds if they are properly to fulfil their
fiduciary duties;

The recommendation by the Myners Commission
in the UK that this interpretation of trustees’
common-law duty be reflected in legislation.

Sorry, Lionel, but you’re wrong

Humpty Dumpty: "When I use a word, it means just what I choose it to
mean." – Alice in Wonderland.

For all his talent as deputy director general
in the department of trade
and industry, Lionel October is not
the ultimate authority on the codes
of broad-based black economic empowerment (B-B BEE).
Last seen, he wasn’t moonlighting as a judge of the
constitutional or high court.

Quoted in Business Report, October insists that the final
codes of good practice exclude black members of retirement
funds from recognition of ownership under the proposed
B-B BEE Act. The final word, however, isn’t his to give.

The codes say what the codes say. They do not say what
October chooses them to mean. Unlike earlier drafts that
expressly excluded retirement funds, the final codes don’t.
They detail the scorecard criteria for black ownership, from
which it follows that they embrace all black people through
all vehicles complying with the B-B BEE criteria.

The codes rate a “triple C” for being confusing,
complex and contradictory. They open a new genre
of BEE consultants, lawyers and verification agencies to a
fees avalanche that will bring no more clarity than October
when he argues:

“Workers could invest in a company through a trust and
this would count as empowerment, but (not) if a group
of black employees were invested in a company as
members of a pension fund.” Pension funds are trusts.
They’re run by trustees as fiduciaries for other people’s
money held in trust. Creation of parallel structures, to
accommodate what October admits is legitimate, is
pointless and wasteful.

“Pension funds are not disadvantaged. They can invest
in large listed companies any time.” So, too, can BEE
consortia. Fund members are trebly disadvantaged
because they aren’t beneficiaries of shares at a discount;
they don’t get preferential funding terms, and their
existing shareholdings are diluted to subsidise consortia
that are less broadly based.

“With the codes we are trying to bring previously
excluded people into the game.” When these people are
members of pension funds, they are already in the game.
It’s a lopsided game that keeps broad majorities of black
fund members off the field to the advantage of
arbitrarily selected minorities. Neither are “previously
excluded people” the same BEE partners featured
repeatedly.

“There were ongoing discussions looking at ways to
recognise pension funds, which would be over and
above the 25 percent direct black-ownership targets.”
Black ownership through pension funds is as beneficial
as black ownership through any BEE mechanism. The
codes provide a “follow-through” principle specifically
to determine “those economic interests or voting rights
to which black people are entitled”. These interests and
rights are exercisable through financial institutions
appointed by pension funds to act on their behalf.

Curiously, his reference to “ongoing discussions” hint
that the “final” codes aren’t final. On October’s version,
there’s still no finality on pension funds and the 25 percent
black ownership target can be increased.

For the codes to enter the statute books in their present
form is to institutionalise perplexity. It also invites
intervention by the Constitutional Court on whether the
claimed exclusion of pension funds is “fair” discrimination
under the bill of rights.

B-B BEE is too important to go the way of Humpty
Dumpty.

This article, by Today’s Trustee editorial director Allan
Greenblo, was published in Business Report last November.